Examining Directors’ Liability under the Negotiable Instruments Act during the Moratorium Period under the Insolvency and Bankruptcy Code (IBC)
To ensure smooth business operations and promote non-cash transactions, negotiable instruments play a crucial role in the economy. They offer an alternative to cash and facilitate uninterrupted business activities. The Negotiable Instruments Act, 1881 (NI Act) was enacted as a criminal legislation to prevent the misuse of negotiable instruments such as promissory notes, bills of exchange, and cheques, thereby fostering trust in these instruments among business entities. The NI Act imposes severe penalties and fines for the misuse of negotiable instruments.
In the case of Modi Cements Ltd. v. Kuchil Kumar Nandi, the Supreme Court emphasized that Sections 138 to 142 of the NI Act aim to enhance the efficiency of banking operations and promote trust in transactions conducted through cheques. However, due to the increasing volume of negotiable instrument transactions, their misuse has become widespread. Since businesses are the major users of negotiable instruments, fraudulent activities associated with their usage can undermine trust in these instruments and have a detrimental impact on the overall economy.
Section 141 of the NI Act specifically addresses the liability of individuals responsible for the business affairs of a company. It aims to prevent directors from misusing cheques and other negotiable instruments for personal gain while hiding behind the company’s shield to evade liability.
The introduction of the Insolvency and Bankruptcy Code (IBC) in 2016 has further expanded the scope of potential misuse of the NI Act. Directors who commit offenses under Section 138 may attempt to evade liability by taking advantage of the moratorium period imposed before the commencement of Corporate Insolvency Resolution Process (CIRP). This raises questions about the accountability of directors under Section 138 read with Section 141 of the NI Act when a moratorium period under Section 14 of the IBC is imposed on the corporate debtor.
LIABILITY OF THE DIRECTORS:
In the case of P. Mohanraj v. Shah Bros. Ispat (P) Ltd, the company was placed under a moratorium as per Section 14 of the IBC. During the proceedings, the directors argued that they should be protected from liability under the NI Act due to the existence of the moratorium. However, the Supreme Court held that the moratorium under Section 14 of the IBC only shields the corporate entity responsible for repaying the debt. It does not provide an excuse for the natural persons involved in the day-to-day operations of the company. The judgment clarified that the moratorium provisions apply solely to the corporate debtor, while the individuals mentioned in Section 141 of the NI Act remain legally liable.
Although a company is a distinct legal entity separate from its shareholders, it cannot function independently and relies on its management, headed by the Board of Directors. While it is acknowledged that the company bears its own liabilities, the law should not be misinterpreted as a loophole for the management or directors to exploit the company for personal gain. Hence, directors can be held accountable for their actions carried out in their capacity as office bearers of the company.
NATURE OF OFFENCES UNDER THE TWO LEGISLATIONS:
In the case of Kusum Ingots & Alloys Ltd. v. Pennar Peterson Securities Ltd, the court emphasized the importance of assessing the accountability of directors on a case-by-case basis and concluded that directors should not be allowed to benefit from their own wrongful actions. Consequently, the directors of the accused company cannot evade their liability for the wrongdoing committed while they were in charge of the company.
It is crucial to recognize that proceedings under the NI Act are criminal in nature, while proceedings under the IBC are civil in nature and can be conducted concurrently. Through an examination of precedents and the reasoning applied by the Supreme Court in various cases, it can be reasonably concluded that proceedings against directors would be valid and comply with the established legal procedures.
In the case of Ajay Kumar Bishnoi v. M/s. Tap Engineering, where the debtor company underwent Corporate Insolvency Resolution Process (CIRP) under Section 31 of the IBC, and a moratorium under Section 14 of the IBC was declared, the Madras High Court ruled that acceptance of the CIRP cannot serve as a basis for quashing the prosecution initiated under Section 138 of the NI Act against the corporate debtor and the relevant Key Managerial Persons (KMP).
Similarly, in Narinder Garg v. Kotak Mahindra Bank, the court deliberated on whether a corporate entity subject to an effective moratorium could be prosecuted under Sections 138 and 141 of the NI Act. The case also addressed the liability of natural persons, such as company directors. The court held that the moratorium provisions in Section 14 of the IBC would apply solely to the debtor company, while the individuals mentioned in Section 141 of the NI Act would remain legally liable under the provisions of the NI Act. Furthermore, when multiple directors are involved, the liability of each director needs to be established individually.
LIABILITY FOR MERELY HOLDING THE OFFICE:
The mere assumption of a position of responsibility does not automatically establish liability on the office bearer. In the case of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr., the accused held a key position, and it could reasonably be presumed that such a person would have been involved in certain company conduct. However, if the accused successfully proves that they had no knowledge of the offense committed or exercised due diligence to prevent such an offense, they cannot be held liable.
On the other hand, in the case of Indus Airways Private Limited v. Magnum Aviation Private Limited, the court interpreted the explanation appended to Section 138 of the NI Act. It clarified that when a cheque is issued to settle a debt or any other liability, such liability must exist on the date the cheque is drawn. If there is no legally enforceable debt or liability on the date the cheque is issued, no offense can be considered to have been committed under Section 138 of the NI Act. Additionally, when a cheque is issued as an advance payment for a contract, the dishonor of such a cheque would not be deemed a legally enforceable debt or liability, and it would not attract an offense under Section 138 of the NI Act.
When a company commits an offense under Section 138 of the NI Act, the directors who were in charge of the company’s related affairs and had control over its activities can be held liable under Section 141 of the NI Act if there is substantial evidence that they were indeed in charge at the time of the alleged default. However, simply holding a position of responsibility for functions related to the offense under Section 138 is not sufficient to establish liability. It must be proven that the accused directors had no knowledge of the offense or exercised due diligence to prevent such offenses.
Furthermore, when a debtor company enters into Corporate Insolvency Resolution Process (CIRP) and a moratorium period is imposed under Section 14 of the IBC, the directors who are liable under Section 141 of the NI Act cannot be shielded from liability solely on the basis of the moratorium period. The protection provided by the moratorium period applies to the debtor company and not the management of the company, who remain liable under Section 141 of the NI Act.